UOL Corporate Finance Exam Questions SET BY Valerie Chai with ANSWERS / Guidelines - SMS +65 97587925 or email enquiry@starcresto.com for UOL tuition

UOL Corporate Finance Exam Questions SET BY Valerie Chai Hui Yee. Please email enquiry@starcresto.com for permission if you want to use the materials. Thank you!

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Section A

Question 1

1a) The news in the morning cited the night trading on the London Stock Exchange in their prediction of how the London Market will perform on opening later in the morning. Why? (9m)

1b) How is put-call parity being enforced? (6m) 

1c) Outline how Myers's Debt Overhang Problem and Jensen & Meckling's asset substitution illustrates that MM Theory of capital structure irrelevance is not valid. (10m)


Sample Answers / Guidelines

1a) London Stock Exchange is the benchmark index for the London stock market. By tracking London Stock Exchange’s overnight performance, it is hoping that the performance can provide an indication on the direction of the London stock market at the opening in the morning.

Define market efficiency and talk about the different efficiency - strong, semi strong and weak and also the empirical evidence. For instance, if the market is efficient, stock market will follow a random walk process and therefore it is impossible to base on overnight trading to predict the market movement. The prediction is based on technical analysis outlook and is nothing more than a estimated guess of where the price for a specific investment is likely to move in the coming minutes, hours, days, weeks and even months.

1b) Put call parity puts a theoretical value for both Put and call options, P + S = C + PV(X) where p is the put price, c is the call price, s is the underlying stock price and PV(X) is the present value of the stock price. Put-call parity only holds for European style options and non-dividend paying stocks.

Put-Call Parity is the relationship that must exist between the prices of European put and call options that both have the same underlying asset, strike price and expiration date. The reason why American options does not hold for Put-call parity is because they can be exercised before to expiry.

If put call parity is violated where the theoretical call value is higher than the market value of call option, then arbitrage profit can be made by buying the call option now since it is cheaper and sell it at the higher price in the future at the theoretical call value. Arbitrage transactions will eventually enforce put call parity.

1c) State what Myers's debt overhang problem is. State what asset substitution is. State what MM theory is. Illustrate with numbers